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The SEC's Internal Battles over Goldman Sachs Probe

Correction, 4/8/2014, 10:00 a.m. EDT:An earlier version of this story said that Fabrice Tourre is appealing his civil fraud verdict. He has not yet announced if he will appeal.The 21st paragraph of the story has been revised to reflect this correction. We regret the error.

One of the continuing criticisms of the U.S. Securities and Exchange Commission is that it is not a fearsome regulator. It didn’t sue the top executives on Wall Street whose actions led to the financial crisis, and it still shows little appetite for targeting the most powerful people at the big financial institutions. In the agency’s most emblematic case arising from the crisis—its 2010 lawsuit against Goldman Sachs & Co. over the Abacus 2007-AC1 investment vehicle—the SEC pursued a low-level vice president and no one higher. The question persists: Why?

Now, more than 2,000 pages of documents newly released by the SEC in response to an American Lawyer Freedom of Information Request sheds fresh light on the Abacus case. They show deep internal divisions at the SEC over the investigation and charging of that case, as one veteran lawyer relentlessly pushed for the SEC to target a more senior Goldman executive, and ultimately failed.

“My experience in this case still bothers me a lot,” said then–SEC lawyer James Kidney in sworn testimony taken in the summer of 2010, a few months after the SEC sued Goldman and junior executive Fabrice Tourre. During 80 minutes of testimony, Kidney vented his frustrations over this case, asserting that the SEC would be more aggressive with a less powerful target. “We take extraordinary inferences and apply them to common little people,” he said. “It still bothers me that we had a lot more than inference here and we didn’t do anything with it.”

Kidney was one of at least 30 SEC lawyers and officials who gave sworn testimony in the summer of 2010 as part of a probe by the SEC’s then–inspector general, David Kotz, into whether the Goldman Sachs case was politically motivated. Kotz included portions of those interviews in a heavily redacted 2010 report that concluded the case wasn’t politically motivated. But the transcripts, obtained through the FOIA, fill in many details. Not only do they reveal more fully the discord within the SEC over the handling of the case, they also suggest that the SEC’s $550 million settlement with Goldman secretly ended roughly a dozen other related investigations into collateralized debt obligations that the agency dropped.

In a statement, the SEC’s new director of enforcement, Andrew Ceresney, declined to address this case, but maintained that the agency has been aggressive. It has filed enforcement actions against 169 individuals and entities arising from the financial crisis, he noted, including 70 CEOs, CFOs or other senior executives, leading to $3 billion in monetary relief. “We’re proud of our record of holding wrongdoers accountable to the fullest extent of the laws we oversee and putting money back in the pockets of harmed investors,” he said.

Ceresney is one of a new group of leaders at the SEC, including chairman Mary Jo White, who have vowed to be tough on securities violators. Many of the cases that Ceresney cites, however, involved companies and firms far smaller than Goldman Sachs; high-level Wall Street executives were barely touched.

The SEC opened its probe into the Abacus CDO in 2008. The agency was investigating whether Goldman misled investors in 2007 by failing to disclose that it let hedge fund manager John Paulson pick poor quality mortgage securities for the CDO and then bet against it. Two large investors lost more than $1 billion.

When Kidney joined the Abacus team in the summer of 2009, he was dismayed at the state of the investigation, which was led by then–associate director Cheryl Scarboro and assistant director Reid Muoio. They were focused on charging Tourre, a 28-year-old Goldman vice president at the time of the deal who was tasked with marketing the CDO. “There were obvious holes in the investigation,” Kidney told Kotz. “This was not a case where there was only one low-level vice president involved.”

Kidney was bothered by what he called Muoio’s “extreme reluctance” to take the testimony of Jonathan Egol, then a Goldman Sachs managing director who supervised Tourre. According to Kidney, Muoio told him he already knew that Egol would say he was too busy to pay much attention to the Abacus deal.

“We were highly unlikely, highly unlikely to have a case against him,” Muoio told Kotz.

Kidney was astounded by this reasoning. “It just seems to me this was the first time in my whole career here that we were not following the string,” he said. “I mean the smallest stock manipulation case, the smallest insider trading case, the smallest almost anything would go at least a little way up the supervisory chain.” Kidney said the issue of taking Egol’s testimony was raised with Scarboro, and then enforcement director Robert Khuzami, and “it wasn’t going anywhere.”

Scarboro told Kotz she supported taking Egol’s testimony; Khuzami said he didn’t recall a dispute over taking the testimony. Scarboro, who is now a partner at Simpson Thacher & Bartlett, did not respond to a request for comment. Muoio, who is still at the SEC, declined to comment, as did Khuzami, who is now a partner at Kirkland & Ellis.

Kidney was further angered when the case was scheduled for a vote by the five commissioners in December 2009 without Egol’s testimony. Kidney threatened to quit the case, and eventually the SEC interviewed Egol on Jan. 7, 2010. Muoio told Kotz the interview was a bust, as he had predicted all along. “We didn’t lay a glove on him,” Muoio asserted. But Kidney said he was encouraged by Egol’s testimony that he had reviewed the marketing materials, as was Lorin Reisner, who was then the deputy director of enforcement. After that interview, the SEC issued a Wells notice to Egol on Jan. 29, 2010, informing him that the enforcement staff planned to recommend charges against him. After a March 4 meeting with Egol’s lawyer, Frank Wohl of Lankler Siffert & Wohl, Khuzami polled the team: Kidney, Reisner and another SEC lawyer wanted to sue, according to the transcripts; Muoio remained against it.

Khuzami had the final say. On March 23 he emailed the team: “I’m a no on Egol.” Khuzami told Kotz the decision was a “difficult judgment call,” but he concluded they didn’t have evidence that Egol had engaged in deceptive conduct. Egol’s emails weren’t as incriminating as Tourre’s.

“Jonathan Egol did nothing wrong,” says his lawyer Wohl. “The SEC clearly got it right when it decided not to sue him.”

Reisner, now the chief of the Criminal Division of the U.S. Attorney’s Office for the Southern District of New York, says he is “completely comfortable” with the charging decisions.

The SEC filed its case against Goldman and Tourre on April 16, 2010. Three days later Goldman reached out with a $500 million settlement offer, according to an email that Reisner sent Khuzami. Although that proposal was close to the final payment, it took another three months to announce a settlement. As Khuzami described to Kotz, Goldman wanted a global settlement that resolved not just the Abacus investigation but the SEC’s probes into roughly a dozen other Goldman CDOs.

Khuzami didn’t want to give Goldman that public victory. When the SEC and Goldman announced on July 16, 2010, that the investment bank would settle the Abac­us case for $550 million, the SEC said in a press release that the settlement “does not settle any other past, current or future SEC investigations against the firm.”

Khuzami was determined that Goldman’s payment only be linked to ABACUS. “This was not a $550 million settlement for 11 cases,” Khuzami told Kotz. “We may tell Goldman that we are concluding our investigations in these other matters without recommending charges, but that doesn’t mean we’re settling them. And that was an important point for us, because we didn’t want them out there saying, you know, they settled 12 CDO investigations for an average of $30 million each, and, you know, didn’t [Goldman] get a great deal.”

Yet in its statement on the Abacus settlement at the time, Goldman said that the SEC had concluded a review of other CDOs and did not anticipate recommending claims for now.

Egol testified as a government witness at Tourre’s trial last summer. Last August a Manhattan federal jury found Tourre liable on six of seven counts of misleading investors, and in March he was ordered to pay more than $825,000. He has not decided whether to appeal. His lawyer, Pamela Chepiga of Allen & Overy, declined to comment. Egol retired from Goldman in February.

Kidney did not stay on the Tourre trial team. He helped lead the SEC’s pending fraud case against former executives of Fannie Mae and Freddie Mac before retiring from the SEC at the end of March 2014, after 24 years with the agency. In a stinging retirement speech Kidney praised his colleagues, but expressed frustration with the agency’s penchant for “picking on the little guys.”

“For the powerful, we are at most a tollbooth on the bankster turnpike,” Kidney said. “We are a cost, not a serious expense. …The system is broken.”